TCS Daily

Sales Tax? Hong Kong Fooey

By Christopher Lingle - July 27, 2006 12:00 AM

Hong Kong's administrative government announced a $1.8 billion surplus for 2005-06. The move to a public-sector surplus in Hong Kong is good news. Until recently, government deficits accounted for 23 percent of GDP, up from 20 percent in recent years. A wave of new spending combined with declining asset prices and deflation had cut deeply into tax revenues.

The disappearance of deflationary pressures in the local economy and a revival in land prices brought an improvement in access to funds. Even so, Hong Kong's administrators have again raised the specter of imposing a sales tax. While this may not be a recipe for disaster, the formula could bring economic heartburn.

The proposal includes a pledge that such an increase in taxes would be revenue-neutral for five years through the introduction of offsetting decreases in other taxes. But an escape clause allows the legislative assembly to waive this pledge if it wishes to spend more money on public services. Given past trends, such a move is likely. Hong Kong has already doubled its spending on social welfare from a decade ago.

Most of the arguments for raising taxes ignore the availability of simpler alternatives that are easier to implement and that will yield quicker results. For example, the quickest method to generate more revenues is to engage in privatization. More land and many of the large physical infrastructure projects, including the airport, could be put on the block.

Privatization provides large amounts of revenues quickly while reducing outflows arising from subsidies or loans to keep government enterprises going. When these entities go into private ownership, they generate tax revenues rather than making claims against government financial resources.

There could be cuts in the scope and payment of the civil service. There are 180,000 civil servants and an additional 170,000 work in government-funded agencies. (Meanwhile, most of the SARs income-tax revenue comes from less than 100,000 taxpayers.) With pay to civil servants accounting for 70 percent of government spending, their salaries are higher than for most in the private sector.

An even better approach to generating fresh government revenues would be to stimulate entrepreneurial activity. Higher economic growth brought about by lower overall taxes can bring in more revenues even at lower tax rates. Meanwhile, lower marginal rates decrease the incentive to evade or avoid taxes. A decrease in tax on profits will encourage investors to start new businesses while a lower tax on savings will encourage capital to into Hong Kong. Both effects would widen the tax base and cause overall revenues to rise.

As businesses expand, overall tax revenues would rise so that budget deficit would be reduced. Calculations by Tim Condon of ING a few years based estimated that a 25 percent cut in profits and salaries tax would generate sufficient additional growth to pay for itself within five to ten years.

Instead of raising taxes, the SAR government should set a high priority on finding ways to reduce spending while raising revenues without increasing the overall tax burden. Otherwise, there is a heightened risk that capital will be attracted elsewhere.

Christopher Lingle is Senior Fellow at the Centre for Civil Society in New Delhi.


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